This ratio indicates how rapidly a corporation can turn its present assets into cash in order to pay down its liabilities on time. Liquidity and short-term solvency are frequently used simultaneously.
The current ratio compares a company’s capacity to pay down current obligations (those due within one year) with its total current assets, which include cash, accounts receivable, and inventory. The better the company’s liquidity condition, the higher the ratio:
Current Ratio = Current Liabilities / Current Assets
The quick ratio, which removes inventory from current assets, assesses a company’s ability to satisfy short-term obligations with its most liquid assets.
Quick ratio= (C+MS+AR) / CL
C – cash & cash equivalents
MS – marketable securities
AR – accounts receivable
CL – current liabilities
Another way is: Quick ratio = (Current assets – Inventory – Prepaid expenses) / Current liabilities
The efficiency ratio is commonly used to assess how well a corporation manages its assets and liabilities inside the organization.
Asset Turnover Ratio
The asset turnover ratio compares the value of a company’s assets to the value of its sales or revenues. The asset turnover ratio is an indicator of a company’s ability to earn revenue from its assets.
Asset Turnover = Total Sales / (Beginning Assets + Ending Assets) / 2
Total Sales – Annual sales total
Beginning Assets – Assets at start of year
Ending Assets – Assets at end of year
Inventory Turnover Ratio
The pace at which a corporation replaces inventory owing to sales in a particular period is known as inventory turnover. Inventory turnover calculations assist companies in making better pricing, production, marketing, and purchasing choices.
Inventory Turnover Ratio = Cost Of Goods Sold / Average Inventory
Average Collection Period
In terms of accounts receivable (AR), the word average collection period refers to the time it takes for a firm to obtain payments due by its customers. The average collection period is used by businesses to ensure that they have enough cash on hand to satisfy their financial obligations.
Average collection period = (AR * Days) / Credit sales
AR – average amount of accounts receivable
Credit sales – total amount of net credit sales in the period